A Reference Guide to Trade Finance Techniques By analysing customers’ payment
practices the invoice discounter could put
pressure on the company to reduce sales
to certain of them.
In a weak trading environment,
increasing proportions of the company’s
cash will be spent on interest payments
to the invoice discounter.
If the invoice discounter fails, this can
cause serious problems for the company
as the company is dependent on it for
working capital finance.
It can be difficult to end a discounting
relationship as the company will rely on
the cash from the invoice discounter to
fund working capital.
Evaluation
Invoice discounting works best for companies
where the company has a relatively large
number of customers all trading on the same
terms, and where the accounts receivable
function can be demonstrated to be effective
and efficient.
It is less effective where the company
is reliant on a small number of customers
(or one major customer) or where each
customer has negotiated its own terms.
Although large numbers of standard
invoices are appropriate as a basis for
invoice discounting, the relationship is
less likely to work if the invoice values are
too small.
Invoice discounting will be cheaper
than a factoring arrangement, although it is
important to recognise that factoring does
include the credit management element. The
finance charge (the interest) may be lower
for invoice discounting than for an overdraft,
because the discounter has security in the
form of the invoice.
Many companies prefer to use invoice
discounting than factoring, because the
company continues to manage the customers
and the sales ledger. However, companies
will need to be prepared for the invoice
discounter to examine their accounts
receivable and credit management processes
before agreeing to extend finance.
Auction-based invoice discounting is still
a new product. It does offer the opportunity
for better financing rates without the risk
associated with a commitment to a single
invoice discounter. However, the flexibility
comes with the risk that funding against any
particular invoice (or set of invoices) may not
be available at very short notice, or only at
very high cost.
It should be noted that both factoring and
invoice discounting receive more favourable
treatment than an overdraft, under the Basel
regulatory regime.